Wells Fargo & Co's (WFC) Management Presents at Morgan Stanley Financials Conference 2016 - Brokers Conference Transcript

| About: Wells Fargo (WFC)

Wells Fargo & Co. (NYSE:WFC)

Morgan Stanley Financials Conference Call

June 14, 2016, 08:50 AM ET

Executives

John Shrewsberry - Chief Financial Officer

Analysts

Betsy Graseck - Morgan Stanley

Operator

Betsy Graseck

All right, so we're going to kick off with a couple of polling questions first, before we get into the fireside chat format. We have John Shrewsberry, CFO of Wells. Thanks so much for joining us today.

Okay, so the first polling question is, other than higher rates since we know in the room people are looking for that to happen this year and September was where most people are interested now John. Other than higher rates what do you think the biggest driver for Wells Fargo shares would be over the next two years; A, stronger organic loan growth; B, portfolio acquisitions; C, accelerating capital return; D, improving operating leverage; E lower energy provisions; or F, stronger fee growth? So six choices; loan growth, portfolio acquisitions, capital return, improving operating leverage, lower energy provisions, and stronger fee growth. Okay, five for organic loan growth and operating leverage as the number two.

Okay, let's go to the next question, how quickly should Wells Fargo grow their investment banking divisions? A, no this is the wrong set of answers. Okay we need to get the right set of answers on here, sorry that was the answer set for the prior question.

The answer set should read, I'm wondering, can you guys fix that or not? All right we'll come back to that.

John Shrewsberry

Was September the latest possible answer for when rates are going up and when you polled people in the last segment…?

Betsy Graseck

No, so we had June and July, September, December, and then 2017. And in fact 2017 garnered up a few answers, may be 2% or 3%, 4%, somewhere in that range, but September was by far, what's your view?

John Shrewsberry

September? Don’t fight the room.

Betsy Graseck

Yes, that was - it was definitely, it is interesting that it was as large as it was because let me tell you, I mean some of the investor conversations we have are nervousness around whether or not it actually even happens this year. So, maybe you could speak a little bit to the ROA and ROE guidance. Now recently at your Investor Day just with a - your outlook time horizon for ROA and ROE guidance is like a two-year type of timeframe. It is not over a cycle, right, it is shorter.

So maybe you could think of – you could help us understand what the drivers were to lowering it and then also is that and end-state in this environment or in this environment can Wells Fargo kind of drive up towards the higher end of that range, just give us a sense of that?

John Shrewsberry

So the reason for doing it, and I guess I'll start by contrasting Wells Fargo with some of the other firms who's output I read, but we've been performing at a pretty attractive level in the 12%, 13%, real, unadulterated ROE environment based on the ROA that we generate in our capital structure.

As rates have remained low for longer, as credit had gotten a little bit tougher in energy for us and with the expense burden that we have at the high end of our 55% to 59% range, we've crept down in both of those calculations to the higher 11% and 12% in ROE in particular. And so this guidance at our most recent Investor Day reflects where we are and where we are likely to be until our next Investor Day two years out. So this is where we set two-year guidance.

And because of this two-year guidance, it is hard to have a fully optimized outcome that’s different because it's only two years and we expect rates to remain lower for some meaningful portion of the two years, even if they start in September, loan rates don’t feel like they are going anywhere fast and normalizing 25 basis points at a time every once in a while doesn’t get you very far on average until you are coming out of the two years.

So we think this is where we're going to operate just being transparent. There are things we can do at the margin things that might happen at the margin that could cause you to tick up or down a little bit, but with everything that we know, it feels transparent to suggest the people that's what they should expect from Wells Fargo which is still very strong compared to our GSIB competitors who are still distributing a lot of capital back to investors at these levels.

Betsy Graseck

So, one of the questions I get is Wells Fargo is a full spectrum lender. You've got lending across all types of asset classes as well as investor or borrower profiles. One potential opportunity set or listing ROA and ROE is to migrate the loan portfolio may be to a little bit of a richer mix yield. Would that be something that you would consider doing or not?

John Shrewsberry

So richer mix yield I think means more credit card right?

Betsy Graseck

Credit card or…

John Shrewsberry

Or low quality commercial assets?

Betsy Graseck

Well, not low quality, but…

John Shrewsberry

The whole risk versus the reward thing.

Betsy Graseck

Right, yes just a question there, so because you are one of the only full-spectrum lenders across all portfolios.

John Shrewsberry

That's right, that's right. I don’t see us leaning on higher yielding loan categories to drive up ROA because you would get the losses commensurate with that at some point through the cycle. So, we are building the credit card business, but not just to drive up the ROA. We're building the credit card business because our customers use credit cards and we want to be their provider. They are always going to be an outcome of doing what we think is right for customers in what we're good at and what we're comfortable with from a risk and return perspective.

Betsy Graseck

Okay. Then we can talk a little bit about just what you're seeing in the portfolio today. You know as we have gone through the year, we've gone through a more euphoric period with rate rise very imminent and sharp and now we're more in a kind of a little more subdued environment with the last data point. May be you can give us a sense as to what you are hearing from your customers and what you are seeing with regard to demand for loans for consumer, commercial, and various buckets?

John Shrewsberry

I think there was only one day of euphoria and that was maybe December 17, 18, of last year. Because as we got into January, things cooled off in a real hurry and as you recall that the sentiment completely changed and people have been digging back from that.

So I think as we, as you go consumer category to consumer category, we may not sell as many cars in the U.S. this year as last year, but there are still a lot of cars being sold and there is a lot of demand for consumer credit in auto.

And as we've talked about on a few different occasions, we've had to sort of step back in some instances because demand for credit is pretty brisk. So I'd say consumers are feeling positive and cars reflect it. In mortgage, it is a stronger year this year versus last year.

Affordability in many places still remains good. Rates are down, so mortgage ability and financing costs are still very attractive. There is more supply. More people have jobs and so that is a – it is a better business. It is a brisker business. And in card for Wells Fargo, it is really more about our penetration, our efforts to put more cards in people's hands because we're not fully indexed to begin with. So, unlike these other businesses, the reflection of what's happening at our portfolio is not really just the consumers propensity to borrow, it is us getting more penetration and that's going well.

On the wholesale side of things, pipelines are not much different than they were a few months ago. One thing that feels different at the margin and I mentioned this earlier this morning to a couple of investors is that there is a little bit more – there is more inquiry right now for strategic activity or the financing related to strategic activity on the part of our customers.

We've had a couple of deals announced this week and I'm sure Morgan Stanley is seeing the same thing. But we are hearing from more customers that they're getting closer to wanting to pull the trigger on strategic acquisitions, maybe it is because financing costs have now come in, those markets have normalized and rates are down.

Maybe it is just that time of the year when they really need to think about what their growth prospects are and how they are going to accomplish them. But that feels slightly elevated otherwise than in the last quarter or two.

Betsy Graseck

Okay, so we could see a little bit more…

John Shrewsberry

Deal activity.

Betsy Graseck

Yes, question on home equity, you mentioned that mortgage is going well. How are you thinking about the home equity book and then we are coming into a period where we have some renegotiations, right, where are you hitting your full spectrum [ph] right?

John Shrewsberry

So the end of draw and the run off of the legacy home equity book is performing better than we would have modeled or anticipated over the last few years really because employment is better. Home prices appreciation has been better. Losses are very contained. I think we've got something like 50 basis points worth of losses in legacy home equity. That was a big topic for Wells Fargo several years ago, not so much today, not really contributing to negative credit performance.

And unrelated on the origination side, I'd say it is a pretty slow origination environment. Home equity is an amortizing product now. It is not quite the same checkbook that it used to be. I think borrowers are conditioned to behave a little bit differently with that product which is probably good. So it is nice to have for some customers. We provide it for them. The legacy portfolio is performing well. We take a big leg down from here both in employment and in home prices for that too, that's already turned around.

Betsy Graseck

Okay, and the shift out of home equity, is there any benefit to the mortgage numbers from that as you refine people from a home equity product into mortgage?

John Shrewsberry

I'm sure it is because we are working with customers who are coming to the end of draw. It is really about putting them into a first that satisfies their first and second problem if they have one and depending on what their LTV is and their capacity to repay it. But that has been, we have used our first mortgage origination capability to help people work through that.

Betsy Graseck

Right, and this 2016 is one of the higher watermarks for this portfolio right?

John Shrewsberry

Sure, if you think about 10 years from 2006 [ph]…

Betsy Graseck

Right, so…

John Shrewsberry

That's been on the horizon for five years and we’ve seen it come and worked with borrowers, et cetera.

Betsy Graseck

Can we talk a little bit about demand in the energy space? I mean obviously that is an area that had been driving loan growth obviously and now you're in a different phase there, but could you talk about whether or not you are seeing that stabilize or is there still some pull back in exposure and then what other parts of commercial are available to offset?

John Shrewsberry

So, demand for credit energy is low which is not surprising. We're working with our customers who will be consolidators on the back half of this disruption in energy, and there will be demand for credit and we'll be happy to provide it, because some of the most interesting loans that were made will happen as we -- as these assets get worked through. The demand for credit in energy services I would say is really, really low because there is just not that much going on there.

In terms of the knock-on effect in commercial, it's - things are slower in energy markets in non-energy activities. So service providers, retailers, commercial real estate, and other things, but it is not really revealing itself as the contributor to incremental losses in our portfolio. The consumer behavior or consumer loan experience in those markets is performing now more on average with the rest of the portfolio.

It was outperforming for a long time because unemployment was so low in those markets and over the last several quarters it has migrated back toward average. I'm sure it's going to get worse as unemployment gets worse and people have to readjust to employment outside the energy sector, that's where it will be for a while. But we're not seeing much of an incremental credit impact on our book overall.

And in terms of loan demand on the commercial side, it is industry by industry, geography by geography, there's no big sector trend that is easy to point to like energy was when business fixed investment, when CapEx was really humming in exploration and the services that we're providing.

Betsy Graseck

And how much of the loan growth in C&I is really industrial production or inventory or that kind of growth versus lend for deals, lend for M&A, lend for buybacks, is there a…?

John Shrewsberry

Yes, I'd say most of it is for the former. Some of it as I said is increasingly around acquisition activity, and then a lot of it is taking share from somebody else in the refinancing of an existing facility as it comes up. There is very little lend for buyback going on in the bank space because this is a little leverage loan capacity to begin with. So it is a pretty healthy mix. It doesn’t feel like it is contributing to activities that are not sustainable.

Betsy Graseck

Okay, so maybe we could see if that polling question could come up the second one, okay. So the question is how as – since we're on the topic of ID and merchants and those kind of things, how quickly should Wells Fargo grow their investment banking division? Okay we have five choices; A, not grow at all; B, grow organically but slower than the rest of Wells Fargo businesses; C, organically at the same pace as the rest of Wells; D, organically faster than the rest of Wells; or E, grow inorganically significantly faster than other businesses? Inorganically is another word for acquisitions.

John Shrewsberry

I know, I know, it is the word we that has no name.

Betsy Graseck

So we thought we'd get investor view here. Okay, C, organically at the same pace, but interestingly a bit of an even split there between faster and slower. So that's I think that shows the tension in the room around this question and I think that the reason we get this question is because you have a great credit rating. You have a lot of capacity in your SLR and in your other capital ratios, but particularly in SLR which is helpful for prime brokerage. And so I can't imagine running an investment bank with such great capital ratios and capacity to do business and not see a ton of business come in so I guess I wonder how you manage through that.

John Shrewsberry

So, this just depends on what you mean by investment banking. So if what you mean is financing asset managers and financing hedge funds then that's a part of the business. But in order to be willing to do that, you have to get a lot of other business from those same people. Using our balance sheet comes at a cost we're trying to generate a 12%, 13%, 14% return on equity and the financing business doesn't do that.

So it will have to be other things that we can do with those customers or for those customers that makes it worth funding them using our, as you described some of our capacity on the leverage ratio side. And so that's a discussion that we have a lot. We have it customer by customer to see what there is to do, what we're good at, what their strategy is, what they want to do. But I don't see prime brokerage is being an enormous business for Wells Fargo and the future. It is a good one. We like it.

It could be bigger than it is today, but it is not going to change the character of our balance sheet. It is not going to change the – we're not going to be having a discussion about ROA next year. And when I say Betsy, I'm sorry, it's so much lower, but we've become a bigger prime broker and it was worth it, that's not a comfortable discussion that we'd want to have.

We're more focused for I should say we're at least as focused on growing the capital raising and advisory business for our corporate and other natural wholesale customers. And as Jon Weiss presented at our Investor Day, that has been going really well, we've got all the customers we could ever want to do business with. We've got roles and activity with all those customers, this is more to do in each case.

So when I think about growing the investment bank, we're already frankly transacting as frequently as anybody else in the U.S. in particular, we really are not growing in investment bank of any meaningful consequence. And in any other part of the world we have distribution rate distribution around the world because we have to, but we just don’t have the same customer base around the world. So it won't look like it does here. But our business here has - we're eight years into this at this point and things are going well.

Our expense base makes sense. Very few people in the business can say that. We don’t have a pile of legacy assets that were sorry that we originated that we have to work through, get the right capital and every customer in the world wants to talk to Wells Fargo because we've got a great reputation right now. So we're taking advantage of those strengths and trying to do more with our customers and it is working out very well.

Betsy Graseck

And the other question we get a lot is how close are you to the GSIB buffers and is there anything that you need to do to make sure that you don’t go up a buffer?

John Shrewsberry

Yes, well as you know because I'm sure your team does these same calculations for Morgan Stanley, it is complex and frankly investment banking and our activity there is not one of the things today that triggers us being close or not close to the various tripwires that would cause a firm to move out.

The things that really dominate our calculation are our overall size which is not likely to change by much. Our level 3 assets became in part because of our mortgage servicing rights that are on the balance sheet. That's something that we have to deal with, the amount of securities that we're involved with because we have a big market cap that works against us in the GSIB buffer calculation. We're a big issuer of high-grade debt in part because of TLAC. That comes back and works against us in the GSIB calculation. So it is things like that.

We're very conscious of our global interconnectedness and replaceability and other things that some of our trading or financing businesses could impact if they got a lot bigger, but at least from a quantitative point of view those are likely to be the items that we're grappling with.

Betsy Graseck

Okay and on the MSR we've had conversations in the past about if you ever had to do something, there is a variety of different stoves [ph] that you have…?

John Shrewsberry

I think there are, I mean those, at the scale where we operate, I wouldn’t describe them as tried and tested, but certainly MSR component pieces get bought and sold all the time. When the MSR looked like a bigger issue from a send [ph] bucket point of view in capital there were technologies that we talked about in terms of moving it off the balance sheet et cetera, we ever had to explore that in any real detail. I suppose we could.

We're comfortable at a 2% buffer. We’re doing the things that we can just to stay at that level and we love the mortgage business. So, we’re unlikely to make it harder to be a high quality mortgage service and we're the largest mortgage servicer in the land.

Betsy Graseck

But does it help that you grow the other parts of the business a little faster…?

John Shrewsberry

It helps a little bit, it matters frankly what other firms are doing at the same time. All these things are indexed to one another, which makes it very difficult to know where you are going to end up at the end of the measurement period.

Betsy Graseck

Okay, what about deposit growth? The reason I've asked this question is, you have a very low loan to deposit ratio right and your deposit growth has been very strong and the question really is when do you have too much of a good thing?

John Shrewsberry

I think you have a too much of a good thing in areas where you are attracting low value from a banks perspective deposits meaning that you don’t get liquidity benefit from them or you pay too much for them in particular and the other certain types whether they are coming from other financial institutions or asset managers or others that are just, they just, they don’t provide the same kind of value.

Most of our deposits are coming from our bread and butter customers, consumer and wholesale customers. And as John Stumpf has said repeatedly, to get the primary deposit relationship with our customers that’s the life – connection between the bank and their customer. We’re not likely to try and shoo those away even though we have a great big deposit number today. There may come a time may be starting in September when deposits are incrementally a little bit more.

Our loan to deposit ratio is lower than it used to be and they will be for all of us these days because of the amount of liquidity that we have to hold. I think we’re still vectoring in on a top quartile type of outcome even for as large as we are and it gives us the dry powder to do more. And of course there will be a day also where whether it’s at the short end of the curve or a little bit further out, we can redeploy some of this excess liquidity in a incrementally more profitable way without taking that much more risk so…

Betsy Graseck

And what are the triggers for that using excess liquidity?

John Shrewsberry

Yes, there are no triggers. There is the constantly revaluated way of thinking about it and it's a tradeoff, it is a tradeoff between assets sensitivity and earnings today or earnings tomorrow, but importantly it’s the capital sensitivity in OCI of getting really invested in 160, 170 entry point timeframe and then living through a 100 basis point back up or more and what that does to capital, that’s part of it.

Betsy Graseck

Right.

John Shrewsberry

And so, we are always asking ourselves like you, like everyone in this room is, where do we think everything that we know today we're going to be six months from now, twelve months from now, how do we look if were up 100, up 200, up 300, what’s going on with earnings, what’s going on with loan demand? What’s going on at the short and long end of the curve, what’s going on with deposit growth at that point in time and what does it mean for our capital levels and capital buffers if we're chewing up OCI.

Betsy Graseck

Right, just if you’re like you are under earning a little bit with so much excess liquidity on the sidelines…?

John Shrewsberry

So, we in the first quarter in particular had let cash build up and I think we've said to investors that that’s not something that we would continue to do. We’d have to get a little bit more reinvested and frankly we’ve taken our assets sensitivity as, way down because we, where we’ve got this belief that regardless of what the Fed does in September or December or whenever, along into the curve feels likely to remain low in dollars for some period of time. I think this morning we went below zero to out to 10 years in Europe, 160, 170, 180 whatever the number is in dollars, probably seems pretty attractive around the world and that is not going to abate any time soon as far as we can tell.

Betsy Graseck

I know you took advantage of some of that low interest rate environment by issuing some debt over in Europe is the right way to think about?

John Shrewsberry

Yes, we’ve issued in a variety of currencies, but we’re on the TLAC trail looking to conform and so when the markets open and Feds are right, we’re getting hit here and there.

Betsy Graseck

And when – how much more do you have on that?

John Shrewsberry

It depends, I mean the final rule is unknown yet, so I don’t know what that is and of course it’s going to depend on what’s RW – what our RWA levels are at that point in the future. But I think we estimated that we probably had 40 or 50 to do and I think we’ve done not even half of that, so we’ve got plenty, we’ve got years to phase it in, but rates are low, spreads are reasonable and so we’re getting in now and...

Betsy Graseck

Oh you still have another three years or so that you could…?

John Shrewsberry

Yes, before we're fully phased in.

Betsy Graseck

And then LCR, I think we’re going to get the details around your LCR ratio as this has to be disclosed soon, is that right?

John Shrewsberry

I’m not sure what it is, but yes it will be more of information.

Betsy Graseck

Yes, okay, all right.

John Shrewsberry

And so and I think what people will begin to appreciate is that LCR is one calculation, but our firms own liquidity stress testing from a regulatory point of view is probably a higher bar in every case or it’s probably not tough enough and that becomes a driving factor for how much liquidity firms hold.

Betsy Graseck

Sure, so I think you will be getting questions around why is it so high and that you'll have to answer us at some future's day.

John Shrewsberry

I’m looking forward to that.

Betsy Graseck

Okay. Any questions from the room? Okay, there is one here hand up over and yep?

Yes, do you foresee the Fed ever letting you get to 100% payout and if you get towards that 100% payout is that likely to come in the form of incremental or higher dividend payout or is it all going to be other forms of capital return?

John Shrewsberry

Yes, so I, with respect to 100% it depends on what we’re telling the Fed in our CCAR proposal, what our plans are and what our requirements are for incremental capital from that point forward. So if we thought that we had no legitimate investment prospects then we would not be growing RWA and we were just stockpiling capital and projecting that our ratios increased beyond an appropriate starting point, I suppose we could make the case for a big payout in that period. If it happened, I don’t think it would be what certainly wouldn’t be from ratcheting up the ongoing dividend because you set an expectation that it remains high.

So it could be more of a one-time dividend or it could be share repurchase. I don’t think the Fed cares much if one gets the one-time is really one-time. That’s not on the table because we’ve been growing RWA and we have planned on making more loans, so we have what we think is a productive use for the capital on our books.

And to push that out there is some uncertainty today as to what the right starting point is because with the prospect of GSIB buffers and CCAR there is a certain expectation that going – go forward capital levels could be a little bit higher for GSIBs and until you know that, you don’t know how much is enough and at some level the Fed knows the answer to that, the industry doesn’t. So, maybe a year from now we'll all know that.

Betsy Graseck

If they took the GSIB, Fed the government indicated they would change the rule for the game right, change the test a little bit and if they were to take out say the single counterparty limit or if they were to take out the double shock that you have to do would that help you much or is?

John Shrewsberry

Sure it could and...

Betsy Graseck

Can you give a sense of how much?

John Shrewsberry

Also no, because it’s their calculation not our calculation and industry, but there is also the issue that they calculate that we’re paying out our base case dividend and paying out or repurchasing our base case shares in that same calculation. There is a big potential offsets or big negatives in that calculation. I don’t know what they are doing to do with them. They might do something, but there are easy things to point to you to say why did this not makes sense.

Betsy Graseck

Right. What about just the dividend payout ratio right? The Fed has 30% type of scrutiny, what if they were to lift that to 40% or 50%, would that change how you think about your payout ratio?

John Shrewsberry

I think we were probably in the mid-40s pre crisis of the industry, I think on average probably in 40, 45. We’re kind of in the mid to high 30s right now in spite of that because our business model has provided the stability of earnings to support that. So we're not really that far from mid-40s.

I do think that there is some flexibility in having a bigger portion of the things being in share repurchase than in dividend. But we have investors who are table pounders for everything should be dividend; we have investors who are table pounders for everything should be in share purchase. So that they can control the timing of when they realize the benefit, we will see.

If part of the feedback on the GSIB buffer in CCAR is that they will treat dividends and repurchases differently in future CCAR calculations and if they treat them differently from one another, I could imagine that changing or influencing anyway the capital policy of banks because if they were tougher on dividends than they were on repurchase, then you'd probably opt for more repurchasing and a more modest dividend.

Betsy Graseck

Okay.

John Shrewsberry

That is out there as a possibility.

Betsy Graseck

Okay. But if there were no, none of these rules, you might, there is no reason why, well I shouldn’t say there is no reason, but the fact that you were at 40%, 45% pre crisis is a useful thing to think about in terms of where you would think?

John Shrewsberry

Maybe it’s a different environment, there is no magic. If you listen to our investors that we have, as I said we’ve got constituencies that feel passionately about all channels. There is something very satisfactory investors are continuously increasing dividend while earnings are continuously increasingly – I get that.

Betsy Graseck

Okay, so just last on payments, I know you've about $1.5 million left and just wanted to get your thoughts on, how you’re planning to utilize the investments that you've been making in payments in particular clear exchange in some of the P2P strategy at this point?

John Shrewsberry

Sure. So I think in the not too distant future many of the larger banks will really sort of announce and recommit to what the future of this, of clear exchange looks like. We’re very excited about it. It is a bank-to-bank, very easy to use at least from our perspective generally free way for person to person payments to happen in real time. I don’t know why anybody would use any other way to do it frankly if the bank was offering it for free, because I’m safe, I'm secure, it’s easy on there.

We’ve got the network that we have among our own customers, the network we have between our customers and the other larger banks who are participating is really big. Each one of us frankly is bigger than anybody else who is participating in this space is a pure play today and so I think it’s going to be sticky.

I think it’s going to be attractive and I think it will take cost out of our business, it will take cash out, it will take checks out and certainly at the margin and then may be more permanently over time we’re excited about it.

Betsy Graseck

We look forward to that announcement.

John Shrewsberry

Me too.

Betsy Graseck

Okay great, well thanks so much for joining us John.

John Shrewsberry

Thanks for having me.

Question-and-Answer Session

Operator

Operator

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